This article explains the differences between Audit, Review, and Compilation services in plain and simple English so that business owners can make better decision when they need such services.
Let say you are applying for a loan or line of credit and the bank require you to provide financial statements of your company. Specifically, the bank requires that the financial statements must be prepared by a CPA firm. In this case, you need the compilation service.
There are two ways a CPA firm can perform a compilation service:
- You do the bookkeeping yourself, then provide financial reports to the CPA firm: general ledger, trial balance, balance sheet, income statement… Based on these reports, the CPA will prepare the financial statements in proper format as required by prevailing accounting regulations.
- You outsource the bookkeeping to the CPA firm and provide basic information: bank statements, credit card statements, vendor invoices… Based on the information, the CPA firm will do the bookkeeping and generate financial statements in proper format.
When the CPA firm completes the financial statements, it will issue a Compilation Report saying that the financial statements are prepared by the CPA in accordance with prevailing accounting standards. The Compilation Report will be attached to the financial statements to be sent to the bank.
In a compilation service, the CPA firm only prepares financial statements based on information and documents provided by the business owners. The CPA firm does not verify or test the documents to ensure that the information is correct.
Let say the bank now needs the financial statements to be more reliable so that they can have some confidence in the financial statements. In this case, it will require a CPA firm to review the financial statements before the financial statements are provided to the bank.
In a review engagement, the CPA firm must be independent with the business. The business owner will do all the bookkeeping, then generate the financial statements and send them to the CPA for review. The CPA firm will review all numbers in the financial statements, compare them to prior years and/or compare them to other sources (e.g. the industry). The CPA firm also calculates several ratios and comparisons. If there are any unusual items or big variances, the CPA will question and discuss with the business owner. If necessary, the CPA firm will propose adjustments to the financial statements.
In a review service, the CPA firm does not verify or test any information or documents. It only performs analytical works as discussed above. These works can detect big errors or mistakes in the financial statements, but does not provide any assurance on the financial statements.
Compared to the compilation, the review provides more reliable financial statements to the bank.
If the bank wants the financial statements to be most reliable and ensure that the financial information is correct, it will require an audit of the financial statements.
In an audit engagement, the CPA firm will perform analytical works (similar to the review) and verify/examine sourced documents to ensure that the financial information is correct and properly presented in accordance with accounting standards. It will also assess the internal controls of the business and report weaknesses, findings, frauds to the business owner so they can improve the systems. These processes require a lot of works and are very time-consuming. That’s why the audit fees are much higher than the review fees or compilation fees.
Please note that no services can provide absolute guarantee that the information in the financial statements is 100% correct. The audit can only assure that the financial statements are free of significant errors (not all errors). However, other errors, if existed, are small and do not affect the reliability of the financial statements. Among all services provided by a CPA firm, the audit provides the highest level of assurance over the financial statements.
CMCD LLC is a full-service firm and can provide all services relating to financial statements. If you need any assistance, please contact us.